The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Sunday, September 1, 2013

Who is holding the risk?

The Economist magazine raised an interesting question in 2003 when it reported on the lack of an answer to the question: who is holding lending risk?

Today, 6 years after the beginning of the global financial crisis, we still cannot answer the question of who is holding lending risk.

Regular readers know that the only way to answer the question of who is holding lending risk is to bring transparency into all the opaque corners of the financial system.

THE world's leading banks decided some years ago that lending is a mugs' game.

They began to get rid of their loans, repackaging them and selling them off as securities, or getting others to re-insure their risk....

Alan Greenspan, chairman of America's Federal Reserve, said in a speech in May that this spreading of the banks' risks has made the financial sector more resilient, and individual institutions within it less vulnerable to shocks.

It can indeed be argued that the world's financial system is safer if banks carry less of the overall credit risk.

Their previous mismanagement of credit has caused so many damaging banking crises in the past; and banks, with their unique role in the payment system and the distribution of liquidity, are prone to systemic risk in a way that is not true of other financial institutions. Better, in that case, that they are strong, and that risks and losses are borne by a wider investment pool.

Others, though, are less sanguine. They fear that credit losses, buried today, will show up in new places later, causing unpredictable damage deep in the world economy....

But analysts and central bankers do not have a complete picture of where the banks' risks have ended up.

One thing is certain. Such risk does not neatly disappear into thin air.

In a weak economy, bad debts increase and banks traditionally take a big hit. If they are not taking the hit in this economic slowdown, then somebody else is.

Credit risk is like air in a squishy balloon. You can squeeze the balloon into any shape you like, but the air does not disappear.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.